Question #7 - Reading 27 Valuation and Analysis of Bonds With Embedded Options

Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers

PDF File: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers.pdf

Page: 3

Status: Unattempted

Shared Context

- In general, the investment team at Matrix attempts to buy "cheap" securities because they are undervalued on a relative basis. What is a characteristic of a "cheap" security for a given Z-spread and effective duration? A) High OAS relative to the required OAS and high option costs. B) High OAS relative to the required OAS and low option costs. C) Low OAS relative to the required OAS and low option costs. Explanation A higher OAS indicates a larger risk-adjusted spread, which leads to a lower relative price. The implied cost of the embedded option in a security with a call feature is the option cost, so a buyer would prefer a lower cost. (Module 27.4, LOS 27.g)

Question

Matrix also currently has investments in several ABS. Which of the following spread measures is most appropriate in the analysis of ABS backed by credit card receivables?

Answer Choices:

A. Monte Carlo simulation model, because representative paths can be utilized

B. Z-spread, because credit card ABS have no prepayment option

C. OAS, because the cash flows are interest rate path dependent. Explanation Credit card receivable-backed ABS have no prepayment option, therefore prepayments are not path dependent and the Z-spread is the most appropriate model. (Module 27.4, LOS 27.g) Alnoor Hudda, CFA, is valuing two floaters issued by Mateo Bank. Both floaters have a par value of $100, three year life and pay based on annual MRR. Hudda has generated the following binomial tree for MRR. 1-year forward rates starting in year: 0 1 2 2% 5.7798% 6.0512% 3.8743% 4.0562% 2.7190%

Actions

Practice Flashcards